After QE3 News, Housing Stocks Risk a Crash

by Jeff Reeves | September 14, 2012 6:45 am

The latest round of quantitative easing[1] announced at Thursday’s FOMC meeting sparked a triple-digit rally in the Dow and a big gain for many stocks.

But if you really want to know what the Federal Reserve’s bond buying program is doing, there’s nothing more dramatic than an intraday chart of the SPDR S&P Homebuilders ETF (NYSE:XHB[2]) to show you what the market thinks.

After all, the buying of long-term bonds by the Fed to push down interest rates is most clearly represented in the form of 30-year mortgage rates, which have bounced around record lows in the last few months. Low interest rates mean an incentive to buy a house, which means a boon to builders.

Thus, this chart: It’s off to the races!

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But lest you think this is the logical culmination of monetary policy and a “bottoming” in housing, I have news for you: The reality is that if you’re not in housing yet, the ship might have sailed.

Don’t start getting cute and betting on builders, or you could get burned.

Consider that the XHB homebuilder ETF has been soaring for months[4] — up about 47% year-to-date after Thursday’s rally. This is hardly something that just happened because of QE3 or improving housing data over the last week or so.

Now consider that XHB is a diversified fund that possesses a share not only in the biggest builders in the business, but also related housing businesses. Top positions right now include Lumber Liquidators (NYSE:LL[5]) and appliance company Whirlpool (NYSE:WHR[6]), diluting the power of the builders.

How could 47% gains be “diluted”? Well, because the builders as individual investments have simply put that gain to shame. And after these run-ups, the valuations are looking kind of rich.

PulteGroup (NYSE:PHM[7]) is up 152% since Jan. 1. That now gives it a forward P/E of 17.5 based on fiscal 2013 forecasts of 91 cents a share based on Thomson/First Call mean estimates. But if you use S&P’s much more conservative forecast of just 66 cents, you’re at a P/E of 24.2.

Ryland Group (NYSE:RYL[8]) is up 90% YTD. Forward P/E is 18.0 from Thomson/First Call and 17.6 from S&P.

Toll Brothers (NYSE:TOL[9]) is up 73% YTD. Forward P/E is 33.5 from Thomson/First Call and 36.2 from S&P.

DR Horton (NYSE:DHI[10]) is up 65% YTD. Forward P/E is 24.0 from Thomson/First Call and 22.4 from S&P.

In short, you’re late to the party, so you very much risk buying a top. Growth already is very much expected based on the big run-ups and high P/E ratios based on 2013’s earnings forecast.

In short, the biggest leg of the “recovery” in housing stocks has already happened, even if it hasn’t been manifested in a real-world recovery for real estate prices or home sales. Yes, the data is improving — but it’s not definitive.

The only way valuations will move higher is if the recovery is even bigger than many have anticipated. And that seems a stretch.

On the other hand, if expectations aren’t met, we could see some pullbacks on even mild reversals in economic indicators like housing starts and home prices.

The lesson here is that the lion’s share of the gains in a recovery rally are always made in the first phase. Think back to 2009 when the indices rallied 60% in the next six months or so … then got choppy and volatile where gains were made in the short-term but didn’t stick. If you waited for the all-clear, you were too late.

Expect that to happen in housing. There is no huge buying opportunity.

That’s not to say that there won’t be gains from here. But the biggest pop has passed you by, so don’t get greedy.

Unless you’re shopping for your first home or an investment property, of course. With rates this low you can get free money — like a 15-year mortgage that basically tracks the rate of inflation if you have good credit and make a big down payment.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[11] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.